Trading With The Time Element

Trading With The Time Element

The very definition of trading is to forecast prices based on either fundamental or technical analysis. While forecasting is referring to where future prices are going (at least this is the general belief), in reality, if one is not incorporating the time element into a forecast, it is not valid.

Let’s take the EURUSD pair as an example. Technical or fundamental analysis may give a price forecast of 1.20, let’s say. But the big question is when is that price going to come? Because if it is coming in ten years from now, then that is not a valid forecast as the vast majority of traders have a much shorter time-horizon.

Therefore, being able to put a time limit on a trade is like putting a stop loss in the sense that if time expires and the target is not reached, the trade should be closed. In this case, time acts as the actual stop loss in price.

There are multiple patterns that allow to trade with time as an important component, and below are only a few:

• Wedges are well known reversal patterns and they can be either bullish or bearish. As a rule of thumb, a rising wedge is always falling (bearish), while a falling wedge is always rising. These wedges are traveling in five waves and they are labeled with numbers (1-2-3-4-5). The classical way to trade a wedge is to draw the 2-4 and the 1-3 trend lines. Aggressive traders will always short a rising wedge when/if the fifth wave pierces the 1-3 trend line, while conservative ones will wait for the 2-4 trend line to be broken, and then retest, before going short. This is a classical interpretation, but what should be the target for the short trade? Price and time are keys here and can be defined easily. With a Fibonacci retracement tool, a trader should measure the length of the whole wedge, and find the 50% level. This is the target for the short trade, or the take profit, and the stop loss should be at the end of the fifth wave. Having said that, what is the time associated with this trade? Take the Fibonacci Time Zones tool and measure the time taken for the whole wedge to form and find out the 50% level. The take profit should come before 50% of the time taken for the wedge to form. Now that we have price and time, assuming price moves in the right direction but doesn’t reach the take profit and time expires, the trade should be closed. This way we’re using both price and time for exiting a trade, a critical thing for trading successfully. The same is valid for a falling wedge, only the direction is on the long side.

• Pennants are other patterns that allow you to use the time element when trading. A pennant is a bullish continuation pattern, so we can only look to buy. In pennants, consolidation takes the shape of a contracting triangle and they form in extremely bullish environments, with RSI usually having values above 50. The thing to do is again, to look for both price and time. In this case, the contracting triangle or the consolidation is forming after a bullish move, almost a vertical one. One should just measure that move and project it by the time the pennant breaks higher. This is the target for take profit. How about time? That target needs to come in less than the time taken for the consolidation (pennant) to form, so the way to go is to measure that time and project it from the moment the pennant breaks. If take profit is not hit and time expires, the trade should be closed.

• Perhaps the most famous for using the time element is the Elliott Wave Theory as Fibonacci numbers and time used for price targets are extremely important for correct labeling patterns. Time and Elliott Wave Theory go hand in hand as counts and patterns are being validated and invalidated by it. In order words, if a specific target/retracement is not happening in a specific amount of time, the count is not good and the analysis should start again. Just to give you an example, the difference between a simple and complex correction is being given by the time taken for price to retrace.

There are many other ways to use the time element in technical analysis but what is important here is to always associate the take profit with a time horizon. It is the only way a forecast is valid.

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